RIAs Gain Foothold in Tricky Options Market

More exchanges, lower volume, liquidity struggles complicate an already complex market

Welcome to the world of options investing, advisors. Now put on your thinking cap and figure out how you can make your visit to this competitive marketplace worthwhile.

That was essentially the message to registered investment advisors (RIAs) at an equity options conference held by the Options Industry Council (OIC) and the Futures Industry Association this week in New York.

Still, the focus placed on welcoming RIAs into the options fold sent an equally strong message that advisors are viewed as an increasingly important segment of the market by the market makers themselves.

“We’re really just getting started with options in the RIA community,” said Jeff Chiappetta, managing director of Institutional Trading and Fixed Income at TD Ameritrade Institutional, in a panel on the new generation of markets. “Retail investors are so much smarter than they were 10 years ago. Those people are challenging their advisors to use products like covered call spreads.”

Uphill Climb

But as RIAs flock to this alternative marketplace, gaining a foothold can be tricky.

While it’s true that clients are demanding high rewards along with low risk in this yield-impoverished economic environment, advisors face a big uphill climb in learning about how options can be used as a portfolio hedge. The challenge comes not just from understanding which options products are best from a risk management standpoint, but also from gaining liquidity in a marketplace that has seen a proliferation of trading venues in recent years.

Growth of U.S. options exchanges has exploded over the last few years, with the number of venues for trading equity options expected to double from six in 2008 to 12 within the next year.

“All of these venues are jostling for a share of the market at a time when total volume has been shrinking,” writes Rachel Koning Beals in Futures Industry magazine’s September issue.

Indeed, options volume has seen a huge decrease. Cleared options contract volume plummeted 43% in August to 313.8 million contracts this year compared with 554.8 million contracts at this time a year ago, according to the Options Clearing Corp. (The OIC notes, however, that although options volume dipped in August, it is still the second highest August on record, after last August, which was the all-time highest monthly volume recorded. This August marked the 24th consecutive month the options industry has recorded at least 300 million contracts in trading volume.)

Confusion About Liquidity

Meanwhile, there’s some confusion among advisors about where they can find liquidity in these increasingly fragmented exchanges, Chiappetta noted, adding that new technology and increased regulation have added another level of complexity to the options market.

Joanne Draper, managing director of equity and options trading at Schwab Advisor Services, said that because RIAs are fiduciaries, and not speculators, their interest in investing in options comes from a desire to find basic hedging strategies.

RIAs also tend to avoid frequent trades because they are cost-sensitive on their clients’ part, Draper noted. And, she said, they typically stay away from new and trendy products such as weeklys while gravitating more toward tried and tested products such as S&P 500 SPX Index Options.

“RIAs are conservative, risk-averse investors,” Draper said, adding that many RIAs who want to use more complicated strategies may sub them out.

Chiappetta agreed, saying, “Even if they’re sophisticated, RIAs may sub out work to managers who do options overlays because advisors want to spend their time talking to clients and not trading all day.”

After the panel, Eric Cott, the Options Industry Council’s director of financial advisor education, stressed that options are a sound risk management tool, but that continuing education is essential for advisors who want to keep abreast of the options market.

Read Fiscal Cliff, Poor Returns Push Wealthy Into Alternatives: Spectrem at AdvisorOne.

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